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  1. 1. The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning inJuly 1997, and raised fears of a worldwide economic meltdown due to financial contagion.The crisis started in Thailand with the financial collapse of the Thai baht caused by the decisionof the Thai government to float the baht, cutting its peg to theUSD, after exhaustive efforts tosupport it in the face of a severe financial overextension that was in part real estate driven. At thetime, Thailand had acquired a burden of foreign debt that made the countryeffectively bankrupt even before the collapse of its currency. As the crisis spread, mostof Southeast Asia and Japan saw slumping currencies, devalued stock markets andother asset prices, and a precipitous rise in private debt.Though there has been general agreement on the existence of a crisis and its consequences, whatis less clear are the causes of the crisis, as well as its scope and resolution. Indonesia, SouthKorea and Thailand were the countries most affected by the crisis. HongKong, Malaysia, Laos and the Philippines were also hurt by the slump. The Peoples Republic ofChina, India, Taiwan, Singapore, Brunei and Vietnam were less affected, although all sufferedfrom a loss of demand and confidence throughout the region.Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in1993–96, then shot up beyond 180% during the worst of the crisis. In South Korea, the ratiosrose from 13 to 21% and then as high as 40%, while the other northern newly industrializedcountries fared much better. Only in Thailand and South Korea did debt service-to-exports ratiosrise.Although most of the governments of Asia had seemingly sound fiscal policies, the InternationalMonetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currenciesof South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. Theefforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia,however. After 30 years in power, President Suharto was forced to step down on 21 May 1998 inthe wake of widespread rioting that followed sharp price increases caused by a drasticdevaluation of the rupiah. The effects of the crisis lingered through 1998. In 1998 the Philippinesgrowth dropped to virtually zero. Only Singapore and Taiwan proved relatively insulated fromthe shock, but both suffered serious hits in passing, the former more so due to its size andgeographical location between Malaysia and Indonesia. By 1999, however, analysts saw signsthat the economies of Asia were beginning to recover.HISTORYUntil 1997, Asia attracted almost half of the total capital inflow into developing countries. Theeconomies of Southeast Asia in particular maintained high interest rates attractive toforeign investors looking for a high rate of return. As a result the regions economies received alarge inflow of money and experienced a dramatic run-up in asset prices. At the same time, theregional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced
  2. 2. high growth rates, 8–12% GDP, in the late 1980s and early 1990s. This achievement was widelyacclaimed by financial institutions including the IMF and World Bank, and was known as part ofthe "Asian economic miracle".In 1994, noted economist Paul Krugman published an article attacking the idea of an "Asianeconomic miracle". He argued that East Asias economic growth had historically been the resultof increasing capital investment. However, total factor productivity had increased onlymarginally or not at all. Krugman argued that only growth in total factor productivity, and notcapital investment, could lead to long-term prosperity. Krugmans views would be seen by manyas prescient after the financial crisis had become apparent, though he himself stated that he hadnot predicted the crisis nor foreseen its depth.The causes of the debacle are many and disputed. Thailands economy developed into a bubblefueled by "hot money". More and more was required as the size of the bubble grew. The sametype of situation happened in Malaysia, and Indonesia, which had the added complication ofwhat was called "crony capitalism". The short-term capital flow was expensive and often highlyconditioned for quick profit. Development money went in a largely uncontrolled manner tocertain people only, not particularly the best suited or most efficient, but those closest to thecenters of power. Another major factor was that these countries became excessively dependentupon exports for their economy. Indonesia, Philippines and Thailand had seen their exports toGDP ratio grow from average 35% in 1996 to over 55% in 1998. Such huge dependence upontrade made these countries susceptible to currency movements. At the time of the mid-1990s,Thailand, Indonesia and South Korea had large private current account deficits and themaintenance of fixed exchange rates encouraged external borrowing and led to excessiveexposure to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s,two factors began to change their economic environment. As the U.S. economy recovered from arecession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raiseU.S. interest rates to head off inflation. This made the U.S. a more attractive investmentdestination relative to Southeast Asia, which had been attracting hot money flows through highshort-term interest rates, and raised the value of the U.S. dollar. For the Southeast Asian nationswhich had currencies pegged to the U.S. dollar, the higher U.S. dollar caused their own exportsto become more expensive and less competitive in the global markets. At the same time,Southeast Asias export growth slowed dramatically in the spring of 1996, deteriorating theircurrent account position.Some economists have advanced the growing exports of China as a contributing factorto ASEAN nations export growth slowdown, though these economists maintain the main causeof the crises was excessive real estate speculation. China had begun to compete effectively withother Asian exporters particularly in the 1990s after the implementation of a number of export-oriented reforms. Other economists dispute Chinas impact, noting that both ASEAN and Chinaexperienced simultaneous rapid export growth in the early 1990s.
  3. 3. Many economists believe that the Asian crisis was created not by market psychology ortechnology, but by policies that distorted incentives within the lender–borrower relationship. Theresulting large quantities of credit that became available generated a highly leveraged economicclimate, and pushed up asset prices to an unsustainable level. These asset prices eventually beganto collapse, causing individuals and companies to default on debt obligations. The resulting panicamong lenders led to a large withdrawal of credit from the crisis countries, causing a creditcrunch and further bankruptcies. In addition, as foreign investors attempted to withdraw theirmoney, the exchange market was flooded with the currencies of the crisis countries,putting depreciative pressure on their exchange rates. To prevent currency values collapsing,these countries governments raised domestic interest rates to exceedingly high levels (to helpdiminish flight of capital by making lending more attractive to investors) and to intervene in theexchange market, buying up any excess domestic currency at the fixed exchangerate with foreign reserves. Neither of these policy responses could be sustained for long. Veryhigh interest rates, which can be extremely damaging to an economy that is healthy, wreakedfurther havoc on economies in an already fragile state, while the central banks werehemorrhaging foreign reserves, of which they had finite amounts. When it became clear that thetide of capital fleeing these countries was not to be stopped, the authorities ceased defendingtheir fixed exchange rates and allowed their currencies to float. The resulting depreciated valueof those currencies meant that foreign currency-denominated liabilities grew substantially indomestic currency terms, causing more bankruptcies and further deepening the crisis.Other economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of thereal economy in the crisis compared to the financial markets. The rapidity with which the crisishappened has prompted Sachs and others to compare it to a classic bank run prompted by asudden risk shock. Sachs pointed to strict monetary and contractory fiscal policies implementedby the governments on the advice of the IMF in the wake of the crisis, while FredericMishkin points to the role of asymmetric information in the financial markets that led to a "herdmentality" among investors that magnified a small risk in the real economy. The crisis has thusattracted interest from behavioral economists interested in market psychology. Another possiblecause of the sudden risk shock may also be attributable to the handover of Hong Kongsovereignty on 1 July 1997. During the 1990s, hot money flew into the Southeast Asia region butinvestors were often ignorant of the actual fundamentals or risk profiles of the respectiveeconomies. The uncertainty regarding the future of Hong Kong led investors to shrink evenfurther away from Asia, exacerbating economic conditions in the area (subsequently leading tothe depreciation of the Thai baht on 2 July 1997).The foreign ministers of the 10 ASEAN countries believed that the well co-ordinatedmanipulation of their currencies was a deliberate attempt to destabilize the ASEAN economies.Former Malaysian Prime Minister Mahathir Mohamad accused George Soros of ruiningMalaysias economy with "massive currency speculation." (Mahathirs claims were couchedin antisemitic terms, and in 2006 he apologized and withdrew the accusations.